Microchip said it was also withdrawing the slate of directors it had nominated previously for election at Atmel’s annual meeting of shareholders.

“I don’t find the move surprising. As the market conditions worsen, there is little need for Microchip to spend money on a hostile merger,” Broadpoint AmTech analyst Doug Freedman said in an e-mail.

Atmel’s microcontroller business had attracted interest from rival Microchip, which teamed up with ON Semiconductor Inc ONNN.O in October last year to make a $2.3 billion hostile bid to buy Atmel.

However, On Semiconductor withdrew from the partnership, and Atmel rebuffed the offer. The $5-a-share offer was 52.4 percent more than Atmel’s closing price on Oct. 1, 2008.

“The global economy and the semiconductor business environment have deteriorated significantly since Microchip first made an offer,” Microchip Chief Executive Steve Sanghi said on Tuesday.

Semiconductor makers around the world are grappling with a near two-year sector downturn, caused by chronic oversupply and weak demand exacerbated by the financial turmoil.

Based on actual results and Atmel’s first-quarter 2009 outlook, Atmel’s revenue will have declined more than 30 percent since Microchip made its bid, and the company is expected to lose money, he said.

In light of economic uncertainty and the lack of visibility that continues to exist with respect to Atmel’s business, Microchip is no longer able to put a value on Atmel, Sanghi said.

Recently, Atmel hired Morgan Stanley to help it explore options for one of its chip businesses, marking the latest step in the company’s effort to cut costs and focus on its microcontroller chip business.

“With Microchip’s withdrawal, we look forward to focusing exclusively on the continued execution of our transformation plan,” Atmel, whose microcontroller revenue grew 14 percent in 2008, said in a statement on Tuesday.

However, Broadpoint’s Freedman said consolidation in the microcontroller industry may be in the offing once market conditions improve.

Shares of Microchip have fallen 29 percent to $20.60, while those of Atmel have risen 19 percent to $3.90 since Oct. 1, 2008. (Editing by Pratish Narayanan)